Breach of Contract Exclusion Applies to Lost Profits Award

A federal district court, applying South Dakota law, has held that a contractual liability exclusion barred coverage for breach of contract damages, including an award of consequential damages in the form of lost profits.  Employers Mut. Cas. Co. v. Brant Lake Sanitary Dist., 2020 WL 1275294 (D.S.D. Mar. 17, 2020).

An insured South Dakota subdivision contracted with a company to build a wastewater system for the subdivision’s residents.  The contract also required the company to secure a performance bond with another entity.  A series of disputes between the subdivision and the contractor resulted in litigation involving the subdivision, the contractor, and the performance bond issuer.  A jury ultimately ruled in favor of the contractor on the subdivision’s claims and awarded three categories of damages: amounts the subdivision retained from paying the contractor, other payments owed under the contract, and the contractor’s lost profits from other projects because the subdivision’s claim against the performance bond issuer hurt the contractor’s ability to secure bonds for other projects.

The subdivision’s insurer denied coverage for the jury award based on the policy’s contractual liability exclusion, which barred coverage for “(1) Amounts actually or allegedly due under the terms of a contract; [or] (2) Failure, refusal, or inability of the insured to enter into, renew or perform any contract or agreement.”  In subsequent coverage litigation, the court agreed that the exclusion barred coverage for all three types of awarded damages.  Both the amounts retained by the subdivision and the other contract amounts were excluded as amounts due under contract.   The court also held that the lost profits award was excluded because it arose from the performance bond that was a part of the contract between the subdivision and the contractor, and only those breach of contract claims were decided by the jury.

The insured argued that the exclusion required a causal connection between the damages and the breach of contract, and that lost profits are consequential contract damages, not direct contract damages.  The court agreed that the lost profit damages were consequential but held that the exclusion still applied because the policy broadly defined damages and nothing in the exclusion dictated that coverage should turn on whether the damages were consequential.  The court further held that application of the exclusion turned on the nature of the claim decided by the jury—here, breach of contract—not the type of damages awarded.